How States Can Design Effective Tax Incentive Evaluation Plans
Best practices for policymakers
Given the importance of tax incentives for states’ budgets and their economies, it is vital to know whether these policies are achieving their goals. To this end, states should establish plans to evaluate their incentives regularly and rigorously so policymakers have up-to-date, reliable information about how well they are working and how they can be improved.
Research by The Pew Charitable Trusts highlights some of the key questions that officials should consider when crafting evaluation plans. Those include examining which programs to evaluate, who will conduct the work, when and how often the evaluations will take place, how to ensure access to needed data, what will be included, and how the results will be used to improve policy.
Q. Which programs will be evaluated?
A. The scope of state evaluations varies depending on specific needs and interests. States often base this decision on the number and magnitude of programs in their portfolios and staff capacity to conduct the reviews. At a minimum, states should evaluate all major economic development tax incentives. Among the possible approaches, policymakers can:
- Focus on economic development tax incentives. Some states, such as Nebraska and Rhode Island, conduct robust reviews exclusively of tax incentive programs such as credits, exemptions, and deductions.
- Evaluate all business incentives. States such as Florida and Mississippi evaluate their complete portfolio of business incentives, including grants and loans, to identify their most effective economic development tools.
- Provide information about incentives for specific companies or projects in addition to broadly available programs. Most evaluations focus on tax incentive programs available to multiple businesses. In some states, however, legislators also enact project- or company-specific incentives. In 2018, Michigan passed legislation to evaluate its broadly available and exclusive incentives.
- Evaluate all new incentives. In addition to existing incentives, states should consider how to incorporate new programs. States such as Connecticut and Oklahoma broadly define the scope of their evaluation processes so new incentives are automatically included in the schedule.
Q. Who will conduct the evaluations?
A. Ideally, the chosen evaluator—whether a state office, legislative staff, an outside contractor, or other arrangement—would have several key traits:
- Experience at program evaluation. Evaluating incentives requires many of the same skills needed to examine other government programs, such as the ability to synthesize interviews with stakeholders, research national best practices, and study the details of how incentives are administered.
- Experience measuring fiscal and economic impact. Evaluators should have the expertise to identify the extent to which incentives influenced businesses’ choices, how those decisions affected the state’s economy, and what it cost to achieve the results.
- An impartial, nonpartisan perspective. Evaluators should base findings on the evidence, as free as possible from preexisting biases and political influence.
- An ability to draw policy-relevant conclusions. To help lawmakers identify how to make economic development policies as effective as possible, evaluators should have the authority to offer recommendations based on what is working and what isn’t, with specifics on how incentives can be improved.
States have options to consider when identifying the best fit for this work. One common approach is to have nonpartisan legislative staff with relevant skills and experience evaluate incentives. Indiana’s evaluation statute requires the Legislative Services Agency to review incentives. Others, such as Colorado, Nebraska, and Washington, require legislative auditors to evaluate incentives.
In a few states, executive agencies do the evaluations. In Iowa and Rhode Island, experienced economists within their revenue departments produce high-quality analyses of the impact of incentives. In Missouri, the state auditor, a statewide elected official, leads the evaluations.
In others, no one office or agency is a perfect fit for this role. For example, Florida law requires two legislative staff offices with distinct skills to review programs together. Oklahoma and Tennessee rely on contractors to conduct evaluations, and Mississippi uses expertise in its higher education system through the University Research Center.
Q. When and how often will programs be evaluated?
A. States need to evaluate their tax incentives frequently enough so that policymakers have up-to-date information but also give time to analysts to produce rigorous, detailed studies. States can:
- Develop rotating review schedules. Many states have adopted schedules in which some incentives are evaluated each year. This approach balances staff workload and provides the time needed to go into more depth than if every incentive were evaluated annually. This also gives lawmakers current information and lets them focus on a subset of incentives. States that focus on economic development incentives typically use shorter review cycles (three to six years), while those with wider scopes are more likely to use longer cycles (seven to 10 years).
- Evaluate tax incentives with similar goals in the same year. Reviewing tax incentives with similar goals as a portfolio of interrelated policies helps identify which strategies are getting the best results. This approach can also show whether incentives with similar goals are coordinated effectively.
- Schedule evaluations to take place before sunset dates. Statutory expiration dates (or “sunsets”) on tax incentives give policymakers an opportunity to review the programs and decide if they should be extended, altered, or allowed to end.
Q. How will evaluators access the necessary data?
A. Unless the selected evaluator already has access to relevant data, plans will usually include provisions that ensure access while acknowledging the importance of protecting sensitive or confidential data. Evaluation laws in several states include data-sharing provisions that balance these priorities. Pew has produced resources with examples of how states have accomplished these goals that can be found here and here.
Q. What should the analysis include?
A. To guide evaluators, evaluation plans list criteria that should be used when studying tax incentives. High-quality reports include a description of the incentive, its history, and goals; an assessment of the program’s design and administration; an estimate of the incentive’s economic and fiscal impacts; and policy recommendations.
Oklahoma’s evaluation law ensures that evaluations consider key factors for measuring the economic impact of incentives, including the success of the programs at encouraging businesses to do something they otherwise would not have done.
States sometimes have different criteria for economic development tax incentives than for other tax expenditures. For example, Hawaii law requires cost-benefit analysis of economic development tax incentives, but not of other tax expenditures for which such quantitative analysis may be less appropriate.
Q. How will the results be used to improve policy?
A. When states evaluate incentives, policymakers should have opportunities to use the results. That way, the evidence provided is translated into policy improvements. Approaches include:
- Hold legislative hearings. Most states that regularly evaluate incentives have designated specific legislative committees to consider the results, receive input from stakeholders, and explore whether policy changes are needed. In Indiana, for example, state law requires the existing relevant committee hold periodic hearings on evaluations. Iowa, on the other hand, created a new committee to do this.
- Use sunset dates to establish evaluation schedules. Sunset provisions encourage lawmakers to carefully consider evaluation findings and use them to inform decisions on whether programs should be extended, altered, or ended. Virtually all of Oregon’s tax credit programs expire every six years—unless lawmakers choose to renew them.
- Communicate findings to executive agencies. This encourages the agencies that administer incentives to pay attention to evaluations. Governments often find that they can improve incentive effectiveness through administrative action without legislation. Executive branch officials help oversee Oklahoma’s evaluation process through the Incentive Evaluation Commission by serving as nonvoting members. As a result, the heads of the Office of Management and Enterprise Services, the Department of Commerce, and the Oklahoma Tax Commission—or their designees—are involved throughout the process and can readily act on panel recommendations.
Josh Goodman is a senior officer, Alison Wakefield is an associate manager, and John Hamman is a principal associate with The Pew Charitable Trusts’ state fiscal health initiative.